Prediction markets are breeding a new generation of market makers
Catholicism warns against gambling addiction. But that didn't stop traders on Kalshi from wagering over $10 million on the answer to "Who will the next pope be?"
Kalshi, along with other prediction-market platforms like Polymarket and ForecastEx by Interactive Brokers (IBKR), allows traders to bet on seemingly just about anything - from egg prices to interest rates to the U.S. presidential election. And while it's easy to scoff at some of the more outlandish prediction markets - like "Will Luigi Mangione plead guilty to murder?" - critics may be glossing over something important.
Although these markets are relatively new, they already are reaching a broad audience and have become quite complex. And just like more traditional financial markets, traders have developed sophisticated arbitrage and market-making strategies to clear hefty sums of cash.
A new generation of market makers
Coby Shpilberg is a 21-year-old who lives in Palo Alto, Calif. With a background in data analytics, he works as the chief technical officer at Adnexi, a clinical-trial startup he co-founded with his mom. At work, Shpilberg uses data science to identify people to participate in clinical trials. Outside of work, he uses that same expertise to trade on Kalshi.
Shpilberg has been trading on Kalshi for about a year. At first, he tried his luck trading markets that revolve around Rotten Tomatoes scores for recent and upcoming movies. He noticed that movie critics would release their reviews, which would then get uploaded to Rotten Tomatoes in batches, thus affecting a movie's score. Shpilberg had a theory that if he built an algorithm that scraped the Rotten Tomatoes website for updates, he'd be able to trade those markets faster than others and thus gain an edge. He tried it but ended up losing money.
Next, Shpilberg had a theory that he could do something similar with the weather markets on Kalshi, using data to predict the temperatures in New York City better than anyone else. Again, he didn't make any money.
In his first six months trading on Kalshi, Shpilberg was down a couple hundred dollars. Then, around the election, things started to change.
"What I was trying to do was essentially arbitrage. I had information where I thought I was quicker than everyone else. So I thought I could buy stuff better. Didn't turn out to be true," Shpilberg told MarketWatch. "But then my mindset switched to do market-making."
And that's when Shpilberg found his edge.
Market makers exist in all types of financial markets, trading things like equities, derivatives and more. In equity markets, the way market-making works is that a market participant, usually a large financial institution, will execute very large volumes of stock orders both on and off exchanges. Market makers are willing to take the opposite side of anyone who wants to trade, making profits by setting their price parameters to ensure they collect a "spread" - which is the small difference between the price a seller is asking for (the "ask") and what a buyer is willing to pay (the "bid"). This difference may be just a few cents or fractions of a cent per stock, but because market makers handle so much volume, they can turn a sizable profit.
For example, the market makers Citadel Securities and Virtu together handled more volume in December 2020 than the entire New York Stock Exchange. Last March, Citadel Securities reported $9.7 billion in trading revenue for the past year.
Kalshi's contracts are binary, meaning each contract has two sides. There's a "yes" side that pays out $1 per contract if a certain outcome happens, and a "no" side that pays out $1 per contract if the outcome doesn't happen. The cost to buy one side of the contract reflects the anticipated likelihood of that event happening, so a "yes" contract that costs $0.60 represents a 60% probability and pays out a net $0.40 if the outcome occurs.
In order to make markets on Kalshi, Shpilberg has resting orders on both sides of the book, and he sets his buy and sell prices wide enough to collect a profitable spread. With this setup, he's willing to sell contracts to anyone buying and buy from anyone selling, as long as they meet his prices. The individual spreads may seem relatively small, but because market-making is a numbers game, Shpilberg is able to profit by executing a large volume of orders.
"That was the real unlock and where I started to become profitable," Shpilberg said.
Although Shpilberg's strategy isn't exactly the same as the market-making done by institutions in other financial markets - where there are strict rules about what institutions can and can't do - it's similar in the sense that the strategy provides liquidity on both sides of a trade and the goal is to collect a spread while remaining position-neutral.
Kalshi has an official market-making program for institutions and other entities that want to make markets on its platform. Financial firm Susquehanna International Group is one of the institutions that participates in this program. Kalshi requires the official market makers in this program to meet certain requirements, undergo auditing and take certain positions to ensure market smoothness and integrity, according to a company spokesperson. The company said that individual traders are not part of this official program and therefore their strategy is not market-making in the official sense. But this also gives those individuals more flexibility in how they trade.
Shpilberg built an algorithm using the Kalshi trading application programming interface, or API, and ChatGPT. This algorithm looks over all the new markets on Kalshi, then checks each market for a list of characteristics that Shpilberg has personally identified. These characteristics tell Shpilberg and his algorithm that the specific market is good for market-making and more likely to be profitable. Once identified, the algorithm sends a notification to Shpilberg through a private Discord server, telling him what to buy. After putting hours into building his algorithm and debugging it, Shpilberg got the process mostly automated and now spends less than an hour per week actually trading on the Kalshi platform.
In just a few months, Shpilberg was able to wipe out his negative profit-and-loss balance and make over $165,000.
Market-making on platforms like Kalshi doesn't always work. Since traders take positions on both sides of a trade, there's a risk of holding the wrong side of the trade at a bad price if the market shifts too rapidly in the other direction. For example, if they are selling "yes" contracts and collecting a $0.02 spread, their entire volume could get picked off if the market thinks that "yes" outcome is much more likely than the market maker has priced.
This means that the traders who are market-making on Kalshi have to be strict about the parameters surrounding what markets they trade in and how much volume they're willing to handle.
"[Kalshi] is a really cool playground to flex these skills and learn how to take advantage of financial markets, and create a little bit of edge," Shpilberg said. "I really believe it's going to create a whole new generation of market makers and introduce, with a very low barrier to entry, automated trading to a whole new generation of people."
Shpilberg said that he once made a post about market-making on Kalshi on his private Snapchat story, and one of his friends responded saying he was market-making on Kalshi, too.
In spring 2023, a group of undergrads at the University of Southern California created a Kalshi market-making algorithm as part of a school assignment. The algorithm ran probability simulations on the daily close of the S&P 500 SPX and entered positions in Kalshi's S&P 500 prediction market that allowed the traders to profit off of a spread. In their test, the students "achieved a $6.80 profit on a $33.40 initial investment" according to their GitHub page.
Jack, a senior at Princeton University who asked MarketWatch not to disclose his last name, has made about $150,000 as a market maker on Kalshi since he started using the platform around the time of the 2024 election.
"I think that there's a clear space for retailesque market makers, which is kind of unique," he said in an interview with MarketWatch.
Prediction markets are evolving
Market-making is far from the only strategy that traders on Kalshi use to seek gains.
"Personally I do see it as a form of investing or day trading. There are also definitely arbitrage opportunities to be found if you know where to look," Hunter Foschini, a 23-year-old who works in sales, told MarketWatch. "I actively look for profitable opportunities daily, and I find them pretty often."
Foschini said his trading strategy consists of doing "deep research" in order to find information to trade on. He also developed his own models and algorithmic trading strategies, which he said has helped give him an edge. While he didn't disclose how much he's made with his strategies, he said he's profitable overall.
"I also know or have spoken with numerous traders who use prediction markets to make a living, and some of them have crossed seven figures in profit," Foschini said.
Prediction markets, in their current form, are still a somewhat recent development. But these markets have been evolving and will continue to evolve. As that happens, they may begin to resemble other once-new markets, like the options market or other derivative markets.
"I think that if this trajectory of success continues, more and more money comes into the markets. And I think that this means betting markets will become more and more efficient," Davide Accomazzo, an adjunct professor of finance at Pepperdine Graziadio Business School, told MarketWatch.